Inheritance Tax threshold to increase to £1m…?

Now that the Conservatives have formed a government, what’s next for their planned inheritance tax shake up?

During the election campaign, you’ll remember the Tory’s promise to remove family homes worth up to £1m from Inheritance Tax, but what does this really mean and how is it proposed to work?

The way Inheritance Tax currently works means that on death, if your total estate exceeds £325,000 (this threshold is referred to as the ‘nil rate band’), then tax will be paid at 40% on the value which exceeds this sum.

Your ‘estate’ is the value of everything you own, including your home, the amount of money you have in the bank and the value of your personal belongings. It’s all added up when you die, and the amounts submitted to HMRC to work out the tax position.

That said, regardless of how much your estate is worth, there currently isn’t any tax charged between married couples or civil partners. This means that you can leave as much as you like to your spouse or civil partner without having to pay any inheritance tax; you can also transfer your nil rate band to your spouse or civil partner. In some cases therefore, you won’t pay any inheritance tax unless your total estate exceeds £650,000.

Although only an issue for wealthier families, in view of increasing property values, there are still many people who will have to pay inheritance tax, and the government took £3.4 billion in inheritance tax in 2013-14.

What about this £1m threshold then?

The Conservatives pledge to introduce a ‘family home allowance’ will mean that some families won’t pay tax unless their estate on the second death is worth more than £1m and it’s proposed to work like this, for deaths after April 2017.

The plan is to introduce a secondary allowance of £175,000 which will be applied to the family home. This £175,000 allowance would be added to the £325,000 threshold to give each person a tax free limit of £500,000.

As this secondary allowance would also be transferable between spouses and civil partners, couples with an estate worth £1m would potentially see no tax due at all. It’s worth noting however, that the new allowance is to be tapered for those leaving more than £2m, with the effect that estates worth more than £2.35m will not benefit at all.

Whilst some may argue that the better course of action would be to simply increase the current nil rate band, at least this planned family home allowance does goes go some way to acknowledging that house price increases have far outstripped the increase in the nil rate band, which has remained at £325,000 since 2009.